Health-care stocks can give your portfolio a shot in the arm

Health-care stocks can offer a prescription for compelling returns. An aging population means rising demand for health-care products and services, new research can give rise to profitable drugs, and innovative small companies can be targeted for takeovers by industry giants.

Health-care companies, which include drug and medical-device makers as well as hospitals, can also be defensive investing plays because they can still do well in a recession. Because exchange-traded funds (ETFs) provide easy exposure to this sector, we asked three experts for top picks for conservative and aggressive investors.

Daniel Straus, ETF analyst, National Bank Financial Inc., Toronto

This health-care ETF, which is well diversified across industry sectors, is the cheapest and most easily tradeable Canadian-listed option, Mr. Straus says. With nearly $400-million in assets, the fund tracks 65 U.S. stocks that are equally weighted. It is 26 per cent invested in health-care equipment, 23 per cent in biotechnology and 15 per cent in pharmaceutical stocks. Among the firms it holds are Alexion Pharmaceuticals Inc. and Cigna Corp., and it hedges its U.S.-dollar exposure back to Canadian dollars. For five years ending Sept. 30, the fund has returned an annualized 16.7 per cent. Like its health-care peers, the fund is “a bit more volatile than the U.S. market,” he notes. The health-care sector can suffer from so-called “headline risk,” whereby statements from politicians and policymakers can also trigger volatility, he adds.

This ETF, which invests in companies expected to benefit from advancements in genomics, is suitable for longer-term, risk-tolerant investors, says Mr. Straus. Genomics is the study of an organism’s DNA, including its genes. This fund, which is actively managed by Ark Investment Management LLC, has 38 stocks. It owns companies involved in health-care innovations, such as stem-cell therapy, bioinformatics and gene-editing technologies. With 65 per cent invested in smaller companies, “this would be a highly speculative, growth-oriented investment,” he notes. For instance, its shares of CRISPR Therapeutics AG stumbled this year after a study raised risks of using its gene-correction technique in humans. The ETF has posted an annualized return of nearly 22 per cent for the three years ending Sept. 30. Its fee is typical of active ETFs, he adds.

This health-care ETF, which owns the world’s largest drug companies, provides a “more defensive positioning for conservative investors,” Mr. Kletz suggests. Among its holdings are Pfizer Inc. and Bristol-Myers Squibb Co., which operate mature businesses and generate stable cash flow, he says. “The size and global nature of these companies yields significant economies of scale.” The ETF, which is 65 per cent invested in the U.S. market, posted an annualized return of 8 per cent for the five years ending Sept. 30. It holds just 25 stocks, so that kind of concentration can be a risk, he notes. A potential headwind is that drug companies, which operate in a regulatory environment, have come under scrutiny for their marketing prices and predatory drug pricing, he adds. “Top-line revenues also tend to get compressed as older drugs come off of patent.”

This biotechnology ETF should benefit from growing demand for drugs to treat ailments affecting an aging global population, says Mr. Kletz. Biotech firms are starting to reap the rewards from studying the human genome to understand genetic causes of disease, he adds. “That opens up new routes to developing treatments.” Biotech firms, he says, are also potential takeover targets for pharmaceutical giants seeking to add them to their research pipeline. The ETF’s equal-weighting approach, however, also “tilts the exposure toward smaller and more speculative companies,” he notes. Stocks of smaller firms “can be highly volatile in response to clinical trial results and regulatory drug-application decisions.” This ETF is one of the lowest-cost, U.S.-listed biotech ETFs, he says. For 10 years ending Sept. 30, the fund has posted an annualized 17-per-cent gain.

The appeal of this ETF, which has about US$10.3-billion in assets, is its very low fee and diversification in nearly 370 stocks, says Mr. Hood. It takes a broader approach than the US$18.9-billion Health Care Select Sector SPDR ETF (XLV-NYSE), which charges a 0.13-per-cent fee and holds 64 large-cap names, he says. Over the 10 years ending Sept. 30, the performance of each, however, has been surprisingly similar, with both posting about a 14-per-cent annualized gain, he notes. The Vanguard ETF is 28.5 per cent invested in pharmaceutical companies followed by 20 per cent each in biotechnology and health-care-equipment stocks. Its top holdings include Johnson & Johnson, Pfizer Inc. and UnitedHealth Group Inc. A risk to the sector is that health-care stocks are pricey, he notes. Stocks in the Vanguard ETF recently traded at 33 times earnings and 4.3 times book value.

This fund, which holds 77 stocks, owns mid-cap names in addition to larger health-care companies, says Mr. Hood. “You can often get good returns out of the smaller caps depending on the market.” For the 10 years ending Sept. 30, the fund posted a 17-per-cent annualized return. The fee is on the expensive side but is worth paying when there is value added, he notes. This ETF focuses on health-care stocks in the Russell 1000 Index. Its stock-selection method ranks companies using growth and value criteria and also involves eliminating the bottom 25 per cent, he adds. The ETF is 36 per cent invested in health-care providers and services, 29 per cent in health-care equipment companies and 13 per cent in biotech firms. First Trust AlphaDEX U.S. Health Care Sector ETF (FHH-TSX) is the Canadian-listed version of this fund, but it charges a 0.78-per-cent fee.

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